San Diego economy faces a sea change during a slow recovery

In terms of a recovery, San Diego is only in the first inning, said The London Group Realty Advisors’ president at a 2013 forecast and trend event at San Diego State University on Wednesday.

Last year was a transitional year economically, with companies and consumers delaying decisions and investments, Gary London said. The economy is looking up in 2013, but the numbers aren’t improving as fast or as far as desired, he said.

“If we look at this recovery in comparison to the last four recoveries that I’ve been through in my adult life, the difference with this one, the reason we added 'great' in front of the word 'recession,' is because this one was deeper and it was longer,” London said. “We’re seeing good numbers. We’re seeing employment increases that are measuring up to 75,000 to 150,000 a month, whereas if we were in a robust recovery, those numbers would be 250,000 a month. And that’s really the difference between this time around and previous times. That has a lot to do with the depth and length of the recession. It has a lot to do with the fact that basically we’re changing economically as a nation.”

The rules are changing, London said, with interest rates at historic lows and San Diego experiencing a “sea change” from adding more suburbs to building mixed-use environments, which have a new norm of being “small and efficient.” The metric to measure office demand is the square feet required per employee, which has fallen from 250 square feet to 125 square feet.

“It’s not because people are getting smaller, it’s because we don’t need file cabinets anymore. So the demand for office space is getting smaller and we’re getting efficient across the board,” London said.

Single-family building is ending as a result of land limitation and a change in demographics. Generation Y is driving the apartment market and will continue to drive that market for the next 10 years, London said. The future of real estate is mixed-use, smart growth and transit adjacent, London said.

A challenge for lenders will be to figure out how to finance people in mixed-use environments, London said.

Timothy Wright, senior managing director at Holliday Fenoglio Fowler LP, said to finance a mixed-use project, the commercial end of it has to be “heavily pre-leased and with a strong tenant.” The people, the credit and the real estate are considered when looking at a loan application, said James Nigro, senior vice president and marketing manager for US Bank Commercial Real Estate. He suggests those with no experience in mixed-use development should align themselves with a partner who does have experience.

“Who’s attracting capital -- it seems to me, at this point in the cycle, that the best projects are getting financing and the best sponsors,” said Wright. “The money is really on the debt side and equity side following sponsorship first. Maybe at end of cycle the project wins out and a more marginal or less credentialed [developer] can pull off a development deal. But right now, it’s the merchant developers, guys with big pipelines, big track records, and well capitalized operating partners that are attracting capital today, not the marginal startup.”

John Wickenhiser, senior vice president and manager at Wells Fargo, said San Diego has “turned a corner” and has experienced a tightening in vacancy rates in different areas, while still having an oversupply in some categories, which is why there isn’t a lot of construction happening.

“The reality is, we can’t lend if the people aren’t asking for money and a lot of the people out there are trying to do this thoughtfully and they realize, 'hey now’s probably not the best time to build a spec office building in San Diego.' So they’re not trying to do that, so we’re not being asked to do it, so it’s not like we’re turning them down,” Wickenhiser said.

Compared to other markets, Wright said San Diego seems “sleepy.”

“I think in '06, we were named the top investment market in the country, downtown was on fire, the whole market was on fire. And it seems that in a downturn, I’ve witnessed through a few cycles, San Diego kind of becomes a secondary plus marketplace. And then in a strong market it gets a lot of attention,” Wright said.

He referenced Seattle, Portland, Ore., and Northern California, which he said have experienced a steeper recovery due to big users such as Amazon (Nasdaq: AMZN) and Google (Nasdaq: GOOG).

“Fundamentally, retail market feels good, office market feels good, apartment market is hot -- but you need big employers. We need to incent these guys to come down here and do some either biotech or telecommunications or some other users to kick things off,” Wright said.